New Zealand raises interest rates again

Vesna Poljak

The Reserve Bank of New Zealand has raised its official cash rate for the second time in two months, lifting rates to 3 per cent as it forges ahead with a policy-tightening cycle to ward off an inflation threat.

The RBNZ confirmed on Thursday it would increase interest rates to 3 per cent from 2.75 per cent amid a period of strong economic growth, in line with economists' expectations. The New Zealand economy grew by 3.5 per cent over the year to March, Governor Graeme Wheeler said, suggesting a slight upgrade from the previous estimate of 3.3 per cent. Last month, the New Zealand central bank became the first in the developed world to raise interest rates in this cycle.

The New Zealand dollar, or kiwi, jumped on the announcement, climbing to US86.24¢ from US85.78¢ defying the RBNZ's claim that the value of the currency is unsustainable. The kiwi rose almost 8 per cent from late January to its 52-week high of US87.16¢ on April 9.

The RBNZ's policy direction also provides valuable clues for the Reserve Bank of Australia which is equally concerned with a high Australian dollar and keeping house prices in check.

However, Australia's March-quarter inflation reading released on Wednesday posed no threat to the RBA's intention for a period of interest rates stability, lending further weight to the view that rates will be on hold in Australia for the rest of this year. The headline consumer price index was comfortably within the RBA's target range of 2 per cent to 3 per cent, coming in at 0.6 per cent for the quarter and 2.9 per cent for the year.

The New Zealand economy has benefited from the stimulatory effects of the rebuilding of Christchurch after the earthquake, strong immigration and unprecedented demand from China and India for its dairy exports.

"Headline inflation is moderate, but inflationary pressures are increasing and are expected to continue doing so over the next two years," Governor Wheeler said in his statement.

"In this environment it is important that inflation expectations remain contained. To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand."

The pace of future rate increases would be dependent on economic data, the central bank added with an eye to the value of the currency. "By increasing the [official cash rate] as needed to keep future average inflation near the 2 per cent target mid-point, the bank is seeking to ensure that the economic expansion can be sustained."

Nomura sees the next RBNZ rate rises coming in June and September. "Future rate hikes, while tied to inflation, will also be dependent on how strong the NZD exchange rate is," said interest rate strategist Martin Whetton. "This mix does put the RBNZ in a bind. Inflation is being driven by the domestic, non tradeable sector and the RBNZ needs to contain it, given low spare capacity. The strong NZD is hurting exports, but it is containing inflation via tradeables."

ANZ's economists said the RBNZ commentary was consistent with lifting the cash rate by 2 percentage points over the next two years. "The governor is leaving some wiggle room on the exact speed of tightening. As always, it's conditional on emerging data and inflation pressure. We expect further 25 basis point hikes in May and June before a pause to assess the impact."